Smart Beta Investing: The No.1 Passive Investing Strategy


I have invested some capital in the smart beta strategy with some significant returns over the past couple of years. I have to say that it is less hassle and less stressful than regular day trading and swing trading. I like the fact that I’m buying into funds that buy shares in tons of securities and I want to share my experience and provide you with a clear picture of what smart beat investing is and perhaps how it could work for you.

Smart Beta investing looks at active and passive strategies and then tries to implement the advantages of each into a smart investment strategy. Good examples of this are ETFs and index funds where people pool their money and purchase stock with thousands of shares that mimics a benchmark (real-estate, stock market, technology) rather than trying to buy individual shares of a company, which is risky. 

In this article, I will go over in detail but give a clear understanding of what smart Beta investing is. We will go over alpha and beta terms and explain how they relate to fund managers and investors. We will then look at how popular smart Beta investing is and some actual examples with real funds and companies that you can check out for yourself and then decide if the smart beta way is a method you would like to use to trade in the stock market.

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What Is Smart Beta Investing

To understand Smart Beta, we have to look at Beta’s definition as well as Alpha’s definition. Alpha and Beta are statistical measurements for calculating returns from equities. This applies to both mutual funds and individual stocks. 

Alpha is how an investment fares compared to an appropriate benchmark. This could be the returns delivered for various companies compared to the FTSE 100 share index or any other like it.

Beta is based on the volatility of an investment. You can think of Beta as the relation between the price swings of the overall market, compared to the price swing of your investment.

We now need to look at fund managers and how they use Alpha and Beta to make trades on the market.

Active Fund Managers

Active fund managers pursue alpha, which means they try to seek returns over and above the market.

Passive Fund Managers

Passive investors acknowledge that it is indeed tough to identify which particular stocks will outperform the market.

A passive investor, rather than pay an active manager to pick their stocks and probably fail, choose to ignore them completely. 

Instead, what passive investors do is invest in an entire market and simply capture the markets’ Beta. They are happy to follow a market both up and down, hoping that the long-term trend will be upwards. They also hope that they are saving a small fortune in charges opting for low cost passive funds in time.

Traditionally passive investors would use index funds weighted according to market capitalisation (the price of individual stock multiplied by the number of shares). Hence the bigger the market cap, the bigger the weighting.

Some downsides to market weight capping could be that it could overweight overvalued stocks, and conversely, it could underweight undervalued stocks, or so skeptics would make you believe.

Market cap skeptics prefer funds that are related to other fundamentals. This could be the size of the company or the dividends that companies return to shareholders. They say that funds related to these fundamentals are a better trade-off between risk and reward than funds based purely on market capitalization.

Smart Beta investors want to have the best of both worlds and are neither active nor passive investors. They want to capture market beta but in the smartest possible way hence the phrase. One thing to note is smart Beta is an umbrella term that lacks definition, and other investors prefer terms such as advanced Beta, alternative Beta, or fundamental indexing.

How Popular Is Smart Beta?

According to the FTSE Russell Global Smart Beta Survey conducted in 2018, 48% of global asset owners used smart Beta. This percentage was up from 26% in 2015, 36% in 2016, and 46% in 2017.

As you can see, smart Beta is growing in popularity, and it is a different way to look at trading as a whole. Let’s look at some examples of Smart Beta investing.

Smart Beta investing is especially popular with the trading and investing platform eToro. There unique CopyTrader feature uses Smart Beta investing principles to recommend the most profitable traders for you to study (and copy).

Who uses Smart Beta Investing

Vanguard Index funds

Vanguard index funds are a type of mutual fund where investors pool their money to buy shares in a fund that mimics a particular benchmark. These investors can be regular people who have regular jobs and are not investors by day.

The index funds are designed to mimic a benchmark, and this could be a benchmark or industry such as the SMP 500, real-estate, or growth stocks. There are about 62 vanguard index funds out there, and they cover a wide variety of different investments.

Index funds contain hundreds if not thousands of stocks within one share of that index fund. Instead of a regular person playing the stock market with a lot of risk and buying individual shares in a company such as Google, Apple, or Microsoft, they purchase shares in an index fund.

Instead of picking individual stocks and bonds, the fund manager for an index fund would purchase all the stock in that specific benchmark that it tracks. For example, you could purchase stock in the VTSAX index fund, and that would literally cover the entire stock market. Therefore, if you invest in VTSAX, you would be exposed to the entire stock market. 

No matter who you are or what you would like to invest in, Vanguard index funds have an index fund that is right for you and your needs. These funds are for people who are just trying to match market returns and not beat them. They are for ordinary people who do not have the time to sift through annual reports and find outliers individual stocks that outperform the market. So, what they do is pool their money and have a passively managed fund and getting on with their lives. 

People invest in Vanguard because they were the originator of the index fund that came out in 1976 and have low expense ratios. This means that what it costs you to invest in these funds compared to their competitors is up to 73% lower than the industry average.

ETF’s & Other Funds

ETF shares are a combination of an index fund and a share. ETFs stand for exchange traded funds. ETFs inherit traits from both index funds and stocks. Just like index funds ETFs are passively managed and diversified at low cost.

Just like stocks, ETFs are bought through a brokerage account and trade on an exchange anytime during the day. This mash-up of desirable traits have made ETF’s increasingly popular investment tools. There are thousands of EFF’s on almost 100 exchanges around the world worth trillions of dollars in assets.

How they work is similar to index funds in that they have a fund that holds actual securities. These securities can vary depending on the ETF. Again, the principle is that instead of purchasing individual stocks, you would purchase ETF shares that deal in those securities that mimic a specific benchmark and many others like it. Those shares trade just like stocks, and those are the two big attractions about ETFs. You don’t need to be wealthy to invest in them, and they are easy to buy, sell, and own.

One thing to note is that ETF’s don’t tend to incur yearly capital gains tax like mutual funds can. You will only pay taxes when you sell your shares in the ETF for a profit.

Conclusion

Smart Beta investing has risen in popularity and exploded over the past few years with trillions of dollars’ worth of shares in. If you are new to the stock market and investing, then an excellent place to start is mutual index funds such as those from Vanguard. Smart Beta investors want both worlds, which are the benefits of active and passive investments.

This is because to invest in Vanguard index funds is way more affordable than that of its competitors. The same goes for ETF shares. It is less risky than trading individual stocks, and you don’t have to be a savvy investor to trade. Index funds are low risk and try to match market returns rather than beat them.

Chris Race

I am an accountant from the U.K. specialising in Management Accounting, Personal & Business Tax, Financial Analysis, and Wealth Management. My passion for learning is what lead me to creating this blog. Stock market investing has always been a interest of mine, and since I was 18 years old... This interest has become a source of income for me and my family.

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